Educational Articles

This week we are running a screen to identify stocks that look to be worthy of further consideration for investors seeking exposure to the energy sector. Our coverage of the sector includes nearly 100 companies across six industries: Coal, Natural Gas (Diversified), Oilfield Services / Equipment, Petroleum (Integrated), Petroleum (Producing), and Pipelines MLPs. Energy stocks are well represented in theValue Line Investment Survey, accounting for about 5% of the 1,700 issues that we follow. Looked at from a market capitalization standpoint, this sector is even more influential, with a combined value of roughly $2.7 trillion, more than 10% of the Value Line universe. The Petroleum (Integrated) group carries a lot of sway in this regard. It includes the five largest companies in the sector, Exxon Mobil Corp. (XOM -Free Exxon Mobil Stock Report), Royal Dutch Shell 'A' (RDSA), Chevron Corp. (CVX - Free Chevron Stock Report), BP PLC ADR (BP), and Total ADR. (TOT), which together have a market capitalization of more than $1 trillion.

In order to identify the energy stocks that are likely to have the most appeal to investors at the moment, we limited our search to those issues that are ranked 1 or 2 in our Timeliness Ranking System, which means they are pegged to outperform the broader market in the year ahead. From this list, we focused on those equities that also offered good price appreciation potential looking out to 2017-2019. In this case, we set the bar at 55%, versus the current median of 35% for the Value Line universe. A Safety rank of 3 or better was also required, which should allow us to steer clear of the riskier holdings in this sector. Finally, in order to avoid fighting negative market sentiment, we also looked for stocks that had produced a positive total return so far in 2014.

Company

Industry

Timeliness

% Price Change

Encana Corp. (ECA)

Natural Gas (Div.)

1

101

Newfield Exploration (NFX)

Natural Gas (Div.)

1

57

Southwestern Energy (SWN)

Natural Gas (Div.)

1

63

Nabors Inds. (NBR)

Oilfield Svcs/Equip.

2

62

Weatherford Int'l (WFT)

Oilfield Svcs/Equip.

2

118

Can. Natural Res. (CNQ.TO)

Petroleum (Producing)

2

72

Ultra Petroleum (UPL)

Petroleum (Producing)

1

96

Of the eight stocks that made the cut, we are taking a closer look at Newfield Exploration Company (NFX). The company explores for natural gas and crude oil in the United States and overseas. Newfield’s exposure to natural gas, which accounted for about 52% of last year’s output, and the weak prices for this commodity in the U.S. have taken a toll on profits in recent years. In all, the company produced adjusted earnings of $1.85 a share in 2013, down nearly 20% from the prior year and well below the peak level of $5.12 reached in 2009.

We expect share net will stay near the current trough levels for another year or two, but initiatives now underway at the company should help to lift the bottom line above the $3 mark by the 2017-2019 time frame, which would likely support good price appreciation for NFX stock. Last year, for instance, Newfield initiated a process of repositioning its business to put further emphasis on its domestic operations, while selling off overseas holdings. Last month’s sale of its Malaysian assets brought in nearly $900 million, and management is now shopping the offshore China business.

These moves should limit the need for additional borrowings in the near term. Long-term debt has increased by more than $1.5 billion already this decade, to $3.7 billion, and cash flow will likely remain insufficient to fully cover elevated capital spending levels for at least the next few years.

Meanwhile, closer to home, the company’s strategy in the U.S. is focused on bringing more of its liquid assets to the surface and to market. Newfield’s domestic holdings are located in the Mid-Continent, Rocky Mountain, and onshore Gulf Coast regions. Overall, U.S. production is targeted to jump 10%-20% this year, to between 44 million and 48 million barrels of oil equivalent (BOE). Liquids (i.e, oil and natural-gas liquids) will lead the way, with output likely climbing roughly 30%. (Natural gas volumes, on the other hand, are expected to be relatively flat.) The company has particularly high hopes for the Anadarko Basin in Oklahoma. It is targeting more than 40% of its 2014 capital budget toward these operations, with the objective of roughly doubling its output there to about 14 million BOE.

Overall, we look favorably on the company’s current strategy to drive increasing liquids volumes from its domestic holdings and think timely NFX shares stand a good chance of delivering above-average price appreciation for shareholders to 2017-2019. The stock, though, does possess some attributes that may prompt some investors to look elsewhere. This equity has a Safety rank of 3, implying an Average risk profile. It does, however, get a comparatively low mark for Price Stability (30 out of 100), likely reflecting the company’s exposure to volatile commodity prices and rising debt levels. In addition, income-oriented investors will likely be put off by the absence of a dividend and the limited prospects, in our view, for the initiation of one in the next 3 to 5 years.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.